Withholding tax is an amount withheld by the party making payment to another (payee) and paid to the taxation authorities.
The amount the payer deducts may vary, depending on the nature of the product or service being paid for. The payee is assessed on
the gross amount, and the tax to be withheld (the withholding tax) is computed in that assessment. The purpose of withholding tax
is to counteract tax evasion and tax avoidance either by domestic or
international taxpayers. In some jurisdictions, the purpose of deduction is also to facilitate or accelerate collection and no
assumption about evasion is inferred.
Domestic withholding tax is applied to earned income in circumstances where the payee might otherwise avoid declaring the
income earned, for example when people work on a contract basis - neither as a registered business nor as an employee. Some
countries require the employer to withhold a certain percentage of that person's income and submit it to the tax authority. In
these circumstances, the payer is usually a business and would normally have to submit details of the identity of the person from
whom this form of tax has been deducted.
Domestic withholding tax is also applied to interest and/or dividend payments, typically at standard rate and paid directly to
the Revenue authorities. This secures immediate payment of at least a substantial proportion of the tax due. Individuals whose
total income does not exceed the higher rate tax threshold need not then complete a tax return (jurisdiction dependent).
International withholding tax is applied in circumstances when the payer is making a payment to another party in another
country and the payment either respect of financing or use of intellectual property. Payments in respect of financing are usually
dividends or interest, while payments in respect of the use of intellectual propery or expertise are royalties, licence fees and
management fees. Most countries permit the payee to claim the amount of withholding tax deducted as a rebate off their their
business income tax.
Employment
In most jurisdictions, employers are required to deduct tax from salary. (See Tax withholding in the United States, PAYE and
Internal Revenue Code 3401). This is often seen as inequitable
where it is conventional for self-employed people to pay their taxes at the end of the year (although, in the United States, they
are required to pay estimated tax each quarter or face interest, while in the Republic of Ireland, self-employed people get just
half the basic tax credit of employed people). Furthermore, the cost to employers of acting as unpaid tax collectors is not
trivial.
Contract and consultancy work
In some jurisidictions, basic rate taxation is withheld from contract and consultancy payments. The consultant may continue to
be liable for higher rate tax on the remainder.
Dividend taxation
A minimum rate of tax may be deducted at source from dividend payments, in addition to
Corporation tax. In the USA, this is still seen as
controversial. In the United Kingdom, the tax is not particularly explicit: tax is withheld at source and the only obvious
indication is disingenuously-named "tax credit" on the dividend statement, meaning that this
is the amount of tax already paid: higher-rate tax-payers have further tax to pay.
The position that arises if the share-holder is not resident in the country concerned is complicated. The country where the
dividend is paid may withhold tax and simply retain it, or it may permit payment gross but inform the tax authorities in the
country of residence (though not in the case of tax havens). A double taxation treaty can partially or fully prevent a single gain giving rise to a tax liability in two
different jurisdictions.
Savings interest taxation
A minimum rate of tax may be deducted at source from savings interest payments. In the United
Kingdom, this is not explicit: tax is withheld at source unless the saver submits an R85
form to claim exemption. In the Republic of Ireland, the tax is explicit and is
known as Deposit Interest Retention Tax or "DIRT".
The position that arises if the saver is not resident in the country concerned is the same as for international dividend
payments as described above. (In the European Union, some member states offer the saver a choice of method to apply).
See also
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